Washington Mutual to stop offering certain subprime loans

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Published: July 18, 2007 5:42 p.m. ET

Last Updated: July 18, 2007 5:45 p.m. ET

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By Lingling Wei Of DOW JONES NEWSWIRES

NEW YORK (Dow Jones)--Washington Mutual Inc.
WM, +0.16%
the largest U.S. savings and loan, has become the latest home lender to eliminate some of the riskiest mortgages to borrowers with scuffed credit or heavy debts.

Effective immediately, the Seattle company will no longer offer subprime mortgages that carry fixed rates for the first two or three years and then reset to higher market rates. Those loans, also known as 2/28 and 3/27 subprime loans, pose higher default risk as the housing slump makes it harder for financially stretched homeowners to refinance or sell their homes.

WaMu will also require subprime borrowers to provide full documentation. Over the past two years, heightened competition has led home lenders to peddle so-called stated-income loans - under which borrowers have to disclose their income but aren't required to provide verification. The skipped paperwork, however, has contributed to higher default rates as some borrowers overstated their financial strength in order to get loans to buy houses they really can't afford.

"I want to emphasize that we remain committed to providing subprime loans to creditworthy borrowers," WaMu Chief Executive Kerry Killinger said in remarks prepared for its earnings conference call after the market close Wednesday.

In recent months, soaring defaults have led to a plunge in investor demand for those risky mortgages, which in turn has pushed lenders to cut back on those loans. Meanwhile, federal bank, thrift and credit-union regulators recently toughened up guidelines to curb weak underwriting standards for subprime mortgages.

In particular, the guidance calls for lenders to take into account the highest possible monthly payments - as opposed to the initial low payments - when deciding borrowers' ability to repay the loans. Many lenders have opposed the proposal, arguing that it could limit credit to subprime borrowers at a time when credit is most needed. Billions of dollars of subprime hybrid adjustable-rate mortgages are set to reset to higher rates this year.

Analysts at Credit Suisse's asset-backed securities research group recently examined the subprime borrowers who last year took out the loans that have fixed rates for the first two years and then adjust to market rates. Their conclusion: About a third of them wouldn't have qualified for the loans had the lenders used the fully indexed rate - not the initial "teaser" rate - in determining the borrowers' repayment ability.

As part of its efforts to implement the new federal guidelines, WaMu also said it will require tax and insurance escrow accounts with all new subprime loans it originates. In addition, the lender will enhance its disclosures and consumer-outreach efforts, including preclosing contact with the borrower even when the borrower has been represented by a broker.

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